Why Energy Regulators are Often Granted Legislated Independence from Government

Why are energy regulators often granted legislated independence from government?

What problems might be expected to arise as a result of such independence?

Argue the case for a set of policies to ensure the regulator does not abuse its legislated powers.

Introduction

This essay will set out to firstly discuss “ liberalisation” of markets with emphasis on the energy sector, and so the “privatisation” of State owned and operated vertically integrated energy facilities. The idealogical notion of what the “Normative” role of an independent regulator should entail and so progress to review real world or “Rational” understanding of the regulator, its objectives along with the subjective side of the individuals involved.

With these ideas explained a review of the problems that this independence brings onto the regulator's office as a virtue of the arena that it has to control.

Lastly the Australian Office of Renewable Energy Regulator ( ORER ) will be considered as an example to see what is in place to ensure legitimate operation of its institutional function.
Liberalisation

Prior to the 1980s, most countries had their energy supply chains owned and operated by the State, thus exhibiting complete vertical integration. Wherein the energy supply chain from raw material, through extraction and transportation, to usage at an electric power station, the subsequent electrical transmission or in the case of natural gas, pipeline transmission, and final reticulation through a distribution system to the end user was entirely run as a single business unit. Such a supply chain necessitates management of vast resources including labour, raw material and finance. Yet at the same time provides for a monopoly that may control the product output and so the price. Chima suggests that such vertical integration characteristics may serve well in a medium to large company looking at securing resources whilst at the same time reducing costs. ( Chima, 2007 ) With regard to the consequences of large nationally owned utilities, there are externalities that place questions on whether they are in fact better off being broken up to operate as smaller more accountable entities. Bouffard et al. writes that as global governments are looking at the consequences of energy security as a result of stoppages from environmental effects, technical issues at the generation facility as well as political items that may arise, the global practice is to break up these vertically integrated monopolies and at the same time open up the market to private concerns ( Bouffard, et all. 2008 ). With examples of the outages in California during 2001 and the North East coast of America in 2003, ( Wikipedia, 2011) that propounded the feasibility of breaking up these vast centralised networks. ( Bouffard, et all. 2008 ) .

These factors as well as the dominant factor of how best to finance new projects have shaped how this energy train is modified. With a majority of European countries having opted to open this market to anyone willing to invest in infrastructure and so liberating what was a closed industry. ( Larsen, et al, 2005 )

To look at an example of how this liberalisation came into play and was accepted universally, consider Britain. Early 1980s and the Thatcher Government is looking for ways to pay for growing debt issues brought on by the down-turn in the economy during that time period. Although it was not a political objective, Thatcher found that the sale of government owned infrastructure could achieve many objectives including:
* provide finance to the government;
* present the notion that private firms can deliver better service;
* allow the population an opportunity of purchasing shares of the large assets and so remove the idea that this was restricted to the wealthy.

At the same time it was possible to eliminate the long standing British socialism doctrine that had a mindset in the labour force for many generations(Elliot, 2001).

This liberalisation process has the intent of providing energy security through diversified concerns, removing the main attribute of major government monopoly from its vertical structure, and by virtue of allowing more players into the market ensuring that competition through market forces keeps the cost of energy at a minimum.
Issues arising from converting public to private monopoly systems.

Of the many issues pertaining to what may happen once a system is privatised, two provide for some review.

The first deals with provision of equitable pricing of services, in this case the cost of the energy unit to the consumer. Anticipation of markets opening up is meant to stimulate competition, as this in turn would bring unit price down for communal benefit. Although there will be additional players that will seek to profit from the open energy market, ultimately there will be but a few opportunities to provide a service. Electric generation facilities will be easily accommodated as demand by the end user will over the long term, inevitably grow. Yet entities such as electric transmission and gas trunk piping offer little scope for new competition and remain as a natural monopoly. Harman notes that it should be essential that such a facility retain its natural monopoly status so to ensure functionality and profitability. These would include national facilities as electricity and natural gas transmission systems, telecommunication, railways, sea and air transport facilities.

Secondly, given the circumstances that encompass the first, Harman then emphasises the need for these natural monopolies to allow open access to both the supply side as well as the demand side of the monopoly structure. So as to allow a number of generators and distributors to profitably operate, ensuring security of supply and a competitive environment ( Harman, 1996 ).
Why regulate?

The Government, having sold the national industry, needs to be seen that it is no longer interfering and possibly using the utility for other political agendas, however, it must still provide for the welfare and benefit of society. How then to control the noted issues of equitable pricing and subsequent open access allowing for a competitive environment?

To use an institutional regulator, that is seen to be at a distance from government, either as independent else by layers of bureaucracy, provides a legitimate resolve. There is a means to ensure competition within the industry, oversee the privatised natural monopolies behaviour with regard to competitive pricing and allowing access to third parties deal[TA1] and arbitrate complaints. The institution may readily analyse and work to circumvent market failure whether it stems from externalities to the industry or if in fact there is an issue from some unrelated directive from the government itself, leading to this failure ( IER 1994 ).
Regulators, independent or tied to a Government.

If the regulator is tied to government it is argued that politicians will intervene for self-interest or for objectives other than regulation. With this in mind, public choice theorists have presented two ideas that explain the regulatory function as well as its status to achieve success. The first being “normative” constituting the expected role of the regulator. Then there is the positive or “rational”, that play into the political arena and how the regulatory institution may be used for subjective reasons.

Jones suggests that although Pareto efficiency is sought, all that may be done will be to internalise the problems ( Jones, 1994 ).
Johannsen expands on this by providing additional concepts:
1/ market failure correction / competition activities;
2/ access overseeing / small consumer protection & complaint arbitration;
3/ security of supply, scrutiny of excessive competition;
4/ decisions independent of government so limiting government failure;
5/ expertise that comes about by way of regulatory rule making and application within the particular industry.

These points are aimed at increasing the credibility of the regulator in his role( Johannsen, 2003 ).

Rational

Jones refers to the “positive” theories whereby “ the role of regulation in advantaging some sectoral group, to the detriment of the rest of society” (Jones, 1994 ), he continues to quote Stigler with regard to his 1971 paper The theory of economic regulation, here regulation is considered as a product and so supplied by the regulator to the demand of the industry that it serves ( Stigler, quoted by Jones, 1994).

Johannsen on the other hand presents “rational choice” as that undertaken by the legislator as a rational actor. The politician needs to implement policy as per the publicly presented plan. Yet the politician must delegate this plan to an agent ( regulator ). It is to be applied without misconception and perpetuated into effect in the event that the politician is moved out of office, Johannsen cites Horn in that there are four costs associated with this delegation:
1/ price for resources to evaluate and decide on the plan;
2/ what costs are borne by the possibility of the plan being upturned;
3/ price of delegation, and so misapplication of plan;
4/ not knowing the outcome of the plan during the decision stage.

Combinations of these costs are used as a means to justify the use of a regulator. Pressures internal to the politician may also lead to the use of this third party that is not associated with the government. An unpopular decision may be presented as that from the regulator, not associated with government. Furthermore, technical aspects have asymmetric information issues that require expertise; along a similar path, decisions that deal with natural monopolies and liberalisation of markets are of little interest to the average voter, and so provide a basis for the delegation to a regulator ( Horn, 1995 cited by Johannsen, 2003 ).

Chekol, in his treatise, refers to the World Bank having seem the effect of government controls, and have made recommendations that countries wishing to look at the path of liberalisation were to strongly consider the objectivity of an independent regulatory organ ( Chekol, 2010 ).
Independent Regulators

In applying the above explanations of the regulators role, there are three key perspectives that are seen as pivotal:
1/ to be seen at arm’s length from government
the office needs to be able to function without any coercive issues arising from government;
2/ to distance itself from all parties concerned
to avoid conflict with who it regulates, regulators would be restricted in having personal interests in the industry
3/ application of decisions independently
may the office apply decisions or does it consult to a department that applies the decision.

In reviewing these criteria with regard to various European countries, Larsen et al., found that all countries surveyed had the regulatory institutions free of the regulated industry's interests. A distinction was made between countries that had privatised state assets, where regulators had decision independence associated with monopoly and competition control. However the countries with traditionally privately owned infrastructure had more of a narrow approach where the tasks are shared with other consumer institutions, such as Germany ( Larsen, et al, 2005 ).

Problems that may arise given independence.

Given that the role requires a specialist it is not likely that they will move jobs. Accordingly, familiarity would lead to opportunities for corruption, between the politician, the regulator and the regulated industry. Capture is one form, the other is misappropriation of information or data, where the regulator is manipulated by the other parties for their self-gain (Boehm, 2007 ). Many provisions are placed to avoid this occurring including: substantial salaries and restrictions on employment by the industry regulated, before, during and after their tenure. Yet even though there lies a paradox of expertise from industry, critics suggest that information asymmetry is best dealt with by the regulator having a background in the industry ( Majone, 1996, cited by Johannsen ).

Autonomy accompanies independence and this in turn questions the accountability of the regulator. Johannsen cites several authors that agree that complete independence with a constituency or some other judicial system to keep ties on the regulator is far removed from reality ( Johannsen citing Majone, 1996, Hall, Scott and Hood, 2000, 2003). To contend with such a problem, Boehm presents that transparency should be omnipresent with all dealings ( Bellver and Kaufmann 2005, cited by Boehm, 2007 ).

Office of Renewable Energy Regulator ( ORER )

The Australian Office of Renewable Energy Regulator ( ORER ) has been set up as a statutory agency, established in 2001 and brought about by the Renewable Energy ( Electricity ) Act 2000 (the Act). Unlike fully independent regulators it is an office within the Department of Climate Change and Energy Efficiency ( DCCEE ) which in turn is a part of the Prime Ministers and Cabinet Portfolio. ( ORER, Compliance, 2011)

Its function is to oversee the renewable energy targets, that constitute the larger wind farms and hydro plants, hence the name Large scale Renewable Energy Target ( LRET ) as well as the domestic level systems or Small scale Renewable Energy Scheme (SRES ). It encourages all levels of renewable energy generation by use of a renewable energy certificate system ( REC ). These RECs are then required to be taken up by an electrical energy wholesaler and, by legislation, presented to the ORER as evidence that they have procured a percentage of their power from renewable sources. Compliance is then a virtue of the legislation. Transactions from generators and purchases are undertaken electronically, which provides merit to the regulator being transparent in its dealings with the regulated industry. (MacGill et al, 2004)

Legislative and Regulatory framework

The LRET and SRES are controlled and monitored through a series of Renewable Energy legislation and regulations that have been amended throughout the life of the Act. These in turn are updated yearly and presented in an annual Regulatory Plan for public review and comment, in effect removing possible elements of external influence other than through the correct communication and review channels ( ORER, Legislation, 2011).
Two layers of amendments take place.
The ORER undertakes changes to the Renewable Energy (Electricity) Regulations 2001, and passes this onto to DCCEE that ratifies the changes and updates the regulations and policy, that may require an amendment to the Act.
To make an amendment the ORER works to a set of rules that include:
1/ final draft to be made public;
2/ review any public comments;
3/ Ministerial approval is then sought for submission to the Federal Executive Council;
4/ Register new regulations with Federal Register of Legislative Instruments;
5/ Regulations are then tabled in Parliament;
6/ Make public the new regulations
( ORER, Regulatory Plan, 2011-2012, 2011)

Misuse of Regulatory Status

Given the framework that needs to be adhered to for policy change, the question of misuse comes to mind. Referring to Boehm, two distinct forms of regulatory corruption or capture may take place, the first is ex-ante capture, dealing with the influence of the regulator during the rule making process, effectively lobbying change to suit an interest group.

The ORER has a set procedure with which the amendments are to be made transparent to the public; subsequently the procedure draws on a number of checks and measures that effectively overlap to ensure that there is no misuse.

The second is ex- post, that would deal with influencing decisions after they take effect; given the circumstances of submission to the parliamentary system it would only be possible to change the policies in the forthcoming year. A lobbying party would have to make its persuasive argument early on to the ORER in anticipation of the office taking on the information and accordingly preparing to make an amendment within the forthcoming year.

Conclusion

Global response to national energy markets has, over a 20 to 25 year period presented a continual pattern of increased use of the regulatory office, in both dependent or independent of government control. The ideology has undergone many changes and certainly seen development over the course of these years. The Thatcher Government, though having a different agenda in obtaining finance, was able to use the liberalisation process to achieve many social objectives. Other countries have followed suit, though in different formats depending on their culture and whether they had national monopolies or decentralised private concerns. As a consequence of such developments across the world the precedences have aptly been used to strengthen policy design of contemporary regulatory institutions.

The Australian Office of Renewable Energy Regulator, that was established roughly 20 years after the British experience, demonstrates that though not independent, it has through procedural administrative changes to the original policy been moulded to provide for a well-worn instrument in administering and policing industry wide controls.

Bibliography

Bouffard, Francois. Kirschen, Daniel S. 2008, Centralised and distributed electricity systems. School of Electrical and Electronic Engineering, University of Manchester, sourced August 2011

Chekol, Abebe Abebayehu. What is the advantage of an independent energy regulation in network-bound sectors. February 2010, University of Dundee, sourced April 2011

Chima, Christopher. June 2007,. Supply chain management issues in the oil and gas industry. Journal of Business and Economics research.